Range Factor: FASB Eyes Broader Fair-Value Disclosures

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Prompted by requests from investors and the Securities and Exchange Commission, the Financial Accounting Standards Board has proposed that companies broaden their disclosures of assets and liabilities to include a range of possible fair-value measurements.

In a proposal issued Friday that would revise its controversial “Fair Value Measurements” standard, the board said it “believes that users will benefit from information about a range of fair value” if a company reports estimates based on “reasonably possible” alternative information about so-called Level 3 assets and liabilities — the most difficult assets and liabilities on companies’ books to estimate — as well as the inputs the company itself favors.

Further, FASB called for added disclosures of changes in Level 1 and Level 2 assets and liabilities, which are based on more verifiable factors than are Level 3 estimates. The board is also calling on companies to break down their estimates more and not merely report net valuations.

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After voting on August 5 to propose a requirement that issuers report on the “sensitivity” of Level 3 estimates to changes in the information such estimates are based on, the board issued the proposal for comment last week. Under its much-debated fair-value standard No. 157 (now called, under the board’s new codification system, Subtopic 80-10), such estimates apply to assets and liabilities that are marked to what is, essentially, a nonexistent or illiquid market.

In such cases, fair value can be determined only through “unobservable inputs” — information that reflects a company’s own ideas about the assumptions market participants would use in their valuations of the asset or liability. In contrast, Level 1 estimates are based on quoted prices in active markets and Level 2 estimates are based on “observable” information, such as quoted prices in similar markets.

“What we’re trying to do is to improve the transparency of fair-value measurements when using these techniques” of estimation, Peter Proestakes, the FASB project manager on the effort, told CFO. While investors were among those pushing for the changes, SEC actions also prompted the amendments, he said. Required by the economic stimulus law to report on mark-to-market accounting, for example, the SEC recommended in December 2008 that FASB consider enhancing fair-value disclosure requirements under U.S. generally accepted accounting principles. Similar International Accounting Standards Board pronouncements were another catalyst for the proposed FASB changes.

In the first of its three proposed amendments to the fair-value standard, FASB wants to require companies to disclose what would happen if they changed one or more of the Level 3 inputs. In such revelations, a company would have to report whether the changes increased or decreased the fair-value measurement significantly and disclose the total effect of those changes.

Under the proposal, reporting entities would also be required to separately report “significant” transfers of assets and liabilities into and out of Levels 1 and 2, as well as the reasons for the transfers. In the third amendment, when companies tote up Level 3 measurements for a reporting period, they would have to report information about purchases, sales, issuances, and settlements separately on a gross basis rather than as the “one net number” they were able to report before, according to the FASB exposure draft.

FASB is asking companies whether they think the costs of compliance with the “disaggregation” of Level 3 reporting would be substantial. Because the provision may involve many judgment calls, they could be costly to some corporations, Proestakes acknowledged. In preparation for the draft, he noted, FASB did a field test with more than half a dozen financial-statement preparers, most in the financial-services sector.

Except for the Level 3 sensitivity disclosure, which would take hold for annual and quarterly reporting periods ending after March 15, 2010, the new FASB fair-value requirements would become effective for reporting periods ending after December 15, 2009. The deadline for comments is October 12, 2009.